Out of the Closet: OPMF Coming at You

"I think we - as the authorities, central banks, regulators, those involved
today - are the inheritors of a 50-year-long, large intellectual and policy
mistake." ~ Lord Adair Turner

We finally found time to finish viewing the keynote presentation of Lord Adair
Turner at the recent INET conference in Hong Kong. In our opinion, it is a
must-see. Mr. Adair's speech validated a new policy frontier for central bank
chicanery and sleight-of-hand. He called it Overt Permanent Money Finance or
OPMF. Moreover, he laid out its theorems visible for all to see. While there
have been veiled references and discussions on this topic in the past, this
was out in the open ... all taboos to the wind. We would consider Mr. Adair's
recent speech as the "coming out" of OPMF.

We'll here briefly explain why you should know about OPMF, what it is contemplated
to achieve, and why it will possibly lead to a new boom-bust cycle like perhaps
never before. First, we'll express it in "formal" language and then we'll tell
you what it really means.

INET, for those who don't know, stands for Institute for New Economic Thinking.
It was founded and funded in large part by George Soros in 2009. Its stated
objective, according to the INET website, is to "accelerate the development
of new economic thinking that can lead to solutions for the great challenges
of the 21st century." While still relatively new, it is gaining much influence
and is attracting high-profile economists such as Lord Adair Turner and others
to its ranks.

George Soros, in an interview at the recent INET conference, expressed enthusiasm
for OPMF. In fact, much more than that. He said something to the effect that,
in his consideration, he believed Lord Adair Turner (advocate of OPMF) to be
one of the most brilliant economists alive today. Whatever you think about
Mr. Soros, an endorsement by such a man of vigor, intellect and unconscionably
huge wealth, urges that you find out why Mr. Turner is considered so brilliant
supposedly.

Just what is OPMF? It is this: To have central banks directly finance the
budget deficits of governments. In other words, central banks would buy new
issue bonds directly from a government's treasury in exchange for newly issued
money. The central banks gets the bonds; the government gets the money in its
bank account to spend. Disappointed? Well, hold on, this is considered genius
(even if you don't think so). Here's the claimed reasoning:

Firstly, lack of demand is the easiest economic problem to fix according
to today's macroeconomists. Since there is a lack of demand today (so it
is reasoned), it is therefore elementary and imperative that something
must be done about it. In fact, to not do so would be irresponsible. (Please
note, these are "their" views, not necessarily that of us raconteurs.)

But, how to raise demand (to get people buying and selling more stuff)
when the household (and entire private sector in some countries) is deleveraging
and pressured to spend less? No problem. Policymakers must continue to
move indebtedness over to the public sector. Get governments to take on
the debts in one way or another. We can deal with government debt more
easily than we can household mortgages and other private debt.

We know that elected governments will never have a shortage of spending
needs. As an economist might put it, governments' proclivity to spend is
bottomless. There is conceivably unlimited opportunity for spending whether "pork
barrel," transfers to the private sector, new and improved bridges ...
maybe even settlements on the moon. In short, you are sure to get a bang
for the buck if you give governments free money. (We can hardly recall
that we used to be told that governments were inefficient and wasted money!)

Once the demand boost is underway, economies can now grow faster ... corporate
profits can soar to even higher shares of national income. Such stimulus
can be created for as long as needed. And, not to worry, OPMF "speedball" injections
directly to the spending aorta can be withdrawn at any time necessary. "Please
believe us, we promise that we will withdraw."

But what about the copious government debt that will fund all this spending?
That's where the "P" in OPMF comes in -- namely, the word "permanent." Actually,
slipping this "P" into the acronym is somewhat disingenuous because what
is really meant is that the debt will never ever be paid back by the government.
Never.

All of the above is brilliant because, among reasons: 1. Giving government
money directly in this way doesn't crowd out other private borrowing; 2.
It provides direct spending stimulus to the economy (as opposed to trying
to generate demand through indirect means ... after all the QE programs
are increasingly losing traction); and 3. It circumvents the demand-retarding
effects of deleveraging in the private sector.

The worst consequence that can be imagined by the OPMF advocates is that
it might unleash some price inflation. But again, not to worry. This is
well controllable by central banks, though we know that this has not been
reliably demonstrated over the "past 50 years." Besides, aren't gold bullion
markets signalling that inflation is not a problem?

In short, brilliant.

We see some deathly theoretical flaws with OPMF. In fact, we potentially see
them to be "society killers." But before that happens, OPMF could trigger quite
a ride in financial markets. It may already be unfolding.

Before we explain further, we'll stop right here for a moment and get something
off our chest. We don't like OPMF. It does not agree with our moral sensibilities.
Yes, we realize that the arenas of Political Economy and Geopolitics are best
engaged with a cold cup of amorality (i.e. no hindrances from any do-right
notions of morality.) After all, the ultimate aim of these two crafts is to
serve the materialistic interests of sovereign nations and their constituents.
We get that.

Nonetheless, we still don't endorse OPMF and for that matter, we will not
apologize for markets nor the reckless policy prescriptions (past and present)
of policymakers. We don't control them. Our job is to manage our clients' assets
and therefore we must remain focused on "what is" rather than "what should
be."

On that note, let's next focus further on a few "what is" factors:

If it is only the government that will get free money (in all of its senses)
under OPMF, then we need to follow what they will be doing with the money.
Upon what will this money be spent? To the extent that government spending
ends up in the private business sector (i.e. buying goods and services
or transferring money to households who then turn around and buy goods
and services,) corporate profits will be boosted. This will be sure to
get stock markets enthused.

If government debt is never contemplated to be paid back to the central
bank, wouldn't it be more correct to say that the central bank gave a free
gift of money to the Treasury Department? We would say yes. This opens
the door to abuse ... and much more malinvestment and economic distortions.

Real wealth cannot be created out of thin air. What these new OPMF policies
must therefore produce is large shifts in relative wealth between different
economic agents and households. Wealth distribution skews will continue
to widen ... the 1% amassing even more relative wealth. (Wealth distribution
is already at its most imbalanced in at least 8 decades in the U.S. not
to mention similar trends in other countries.) This is one of the structural
problems to begin with.

While Mr. Adair and other erstwhile and mutually-congratulatory money alchemists
will no doubt continue to reinforce the notion that their ideas are new and
brilliant, they are in fact not. The underlying premise -- buried under mile-high
sedimentary layers of academic-speak, theoretical obfuscation, references to
dead economists and so on -- is a fascist wealth transfer. That's harsh language.
Even harsher (and more accurate still), is the word theft. When massive amounts
of wealth are being transferred by effect of the policies of an unelected central
bank (not by way of labour or savings nor a properly empowered congress) what
would you call it, dear reader?

We also have to consider the impact of OPMF upon currencies. All of the above
theories of the "new thinking" magisterium, assumes that impacts upon currencies
will be quite orderly because all major central banks will be nicely cooperating
together. This is hardly sure and the potential impact upon individual country
stock and bond markets of any dissonance will be sure to be quite marked. This
will mean both opportunity and risk.

What also is not sure is the actual long-run impact of OPMF. Beyond an initial
financial euphoria, the long-term impact could be directly opposite to what
policymakers may believe. Besides a further concentration of wealth, we could
make a case that a continuing low-interest environment will push the corporate
sector even further into dividend-paying mode, cutting capital spending, even
as the household sector suffers a much further contraction in real income.
All of this could actually be deflationary. In short, there are plenty of reasons
to expect that the "50 year policy mistakes" by ambitious central bankers could
continue.

Were we pushed to the wall, we would say that the world of Overt Permanent
Money Finance is already upon us. Clandestinely, thanks to the Bernanke Fed,
it may already have been in force for two years or more. The U.S. Fed has already
bought a lot of U.S. treasury bonds (at last count, $1.86 trillion worth).
If you believe that these bonds will never be sold back to the public sector
or paid back by the government, then you are asserting that OPMF is already
underway. The stock market, by all appearances, seems to already know that.

If you've been puzzled by the inexplicable strength of stock markets in recent
months, despite a clearly decelerating economic ebb and wilting earnings, then
the growing expectation of OPMF could be your answer. Stock markets may already
be "looking through" the current economic slowdown to the halcyon promises
of the dawn of the age of OPMF.

Of course, we recognize that no future scenario will have a 100% probability.
However, the one that we have outlined here just happens to be one of the current
eight that have been part of our strategy set for a number of years. Its probability
of occurrence is rising fast.

Looking ahead, having been given the stewardship of our client's assets, we
must strive to stay ahead of the monetary machinations and competitive unorthodoxies
of the major central banks. The "new economic thinking" being applied, therefore,
also requires new portfolio strategies.

As such, many economic theories and financial market response have been entirely
turned upon their head. Today's financial markets are far more theoretically
treacherous and non-intuitive. The obvious may not be what it seems; and opportunity
may lie right in the mouth of the lion. In a sense, the latter is the situation
we see possibly playing out. OPMF, while at first appearing as a gift in the
mouth, will turn out to be a hominus-eating carnivore.

As OPMF gains further influence in policy circles, we speculate that financial
markets (both bonds and stocks ... the latter certainly so) will initially
be (perhaps already is) in a celebratory mode. In fact, it may yet be a full-blown
punch bowl party. Intoxicants such as free money and free government funding
will do that. But only for a time. The flaws that we have cited will, in time,
come to the fore.

In conclusion, we think it is a significantly high probability that OPMF will
be implemented in time by all of the major central banks of the world (with
the possible exception of a few ... the Bundesbank?). Why? Because the major
economic hindrances that the western world is experiencing are not entirely
the result of high indebtedness alone, but, also some serious structural issues
(i.e. demographics, uneven wealth distribution as mentioned, massive malinvestment
overhang ... etc.). The economic growth disappointments borne of such factors
will prompt greater calls for OPMF. As such, along the way, we must expect
sharp slumps in stock markets from time to time, creating the crisis environments
that break the policy inertias that may stand in the way of OPMF. These will
also likely be stock buying opportunities.

Should OPMF possibly play out as we theorize, it will be a market environment
that few can afford to miss ... most crucially so for future retirees. Equity
markets are likely to the greatest beneficiary. More than ever, macro tactical
strategies are called for. We will be sure to keep our "new thinking" hats
on tight; stay wary of erudite sophistries; and above all, keep our hands on
our pockets.

Wilfred Hahn is intimately familiar with the many facets and challenges of
the world of money, having worked in the global financial and investment industry
for over two decades.

Business and research travels have brought Wilfred to 40 countries around
the world, allowing him a unique opportunity to keep abreast of global developments
and to maintain an international network of contacts. He is a published author
and has written on global financial markets, ethics and stewardship issues.
When Euromoney Magazine asked fund managers around the world to name
their favorite domestic and international research analysts, Wilfred was chosen
one of them. Many foreign publications around the world have quoted Wilfred,
including the South China Morning Post, Wall Street Journal, New York Times,
Frankfurter Allgemeine, and the Financial Post. He has made numerous
appearances on various television and radio broadcasts.

Prior to founding Hahn Investment Stewards, Wilfred was head of the Global
Investment Group of the Royal Bank of Canada. In this position, he built the
global discretionary business of this institution, comprising the activities
of staff in nine countries and assets of clients totaling in excess of $10
billion. The group's many clients around the world included pension funds,
corporations, mutual fund unit-holders and private individuals.

Prior to the Royal Bank he co-founded Hahn Capital Partners Inc. - a global
investment counseling firm that was sold to the Royal Bank of Canada. Earlier
in his career Wilfred was Senior Vice President, Director of Research of Prudential
Bache Securities. There he gained extensive global experience, establishing
a high ranking as a financial market strategist. Earlier, Wilfred was a partner
in the investment banking firm of Gordon Capital Inc.